The Financial Accounting Standards Board added a hot item to private company accounting and finance professionals’ summer reading list.
It comes in the form of a proposed Accounting Standards Update aimed at simplifying consolidation rules for variable interest entities. The proposed ASU, stemming from a recommendation of FASB’s Private Company Council, would provide a “private company alternative” to simplify accounting for VIEs, with the scope of private companies being all entities except for public business entities, not-for-profits, and employee benefit plans.
- A private company would not have to apply VIE guidance to legal entities under common control if both the parent of the commonly controlled group and the legal entity being evaluated for consolidation are not public business entities.
- The accounting alternative would be an accounting policy election that a private company would apply to all current and future legal entities under common control that meet the criteria for applying this alternative.
- If the alternative is elected, a private company still would be required to follow other consolidation guidance, particularly the voting interest entity guidance, unless a scope exception applies.
- Under the accounting alternative, a private company would provide detailed disclosures about its involvement with and exposure to the legal entity under common control.
- Amendments in this proposed ASU would expand the private company alternative for common control leasing arrangements to all private company common control arrangements as long as both the parent and the legal entity being evaluated for consolidation are not public business entities
Related party interests are also addressed in the proposed ASU, which would “eliminate mandatory consolidation for situations in which power is shared among related parties or when commonly controlled related parties, as a group, have the characteristics of a controlling financial interest (but no reporting entity within the related party group individually has the characteristics).”
How much will the proposed ASU help?
The proposed ASU carries its own complexities in establishing which entities meet the criteria to apply the simplified alternative. The last bullet point above, as to status of both the parent company and the legal entity being evaluated for consolidation, is a key consideration.
Additonally, the section of the proposed ASU dealing with related parties, which aims to simplify determining which entities among a commonly controlled group must consolidate VIEs, includes the following points:
- The amendments would eliminate mandatory consolidation for situations in which power is shared among related parties or when commonly controlled related parties, as a group, have the characteristics of a controlling financial interest but no reporting entity individually has a controlling financial interest.
- Instead, when a reporting entity within the related party group under common control or in a related party shared power situation concludes that substantially all of the activities of the VIE do not involve and are not performed on behalf of any single entity in the related party group, then the reporting entity would consider whether it has a controlling financial interest in the VIE.
- In doing so, the reporting entity would determine whether it should attribute decision making to itself by considering the following factors, none of which are determinative in isolation: 1) The purpose and design of the VIE. 2) The relationship and significance of the activities of the VIE to the related parties. 3) The nature of the reporting entity’s exposure to the VIE (for example, through pro rata equity, senior interest, subordinated interest, and so forth). 4) The magnitude of the reporting entity’s exposure to the variability associated with the anticipated economic performance of the VIE.
- Situations may exist in which no party in a shared power arrangement or within a related party group under common control concludes individually that it has a controlling financial interest in the VIE after considering those factors.
- When related parties under common control, as a group, have a controlling financial interest, the parent entity would consolidate the VIE unless a scope exception applies, regardless of the conclusions reached by the individual related parties under its control.
Separately, the proposed ASU aims to simplify reporting of decision-making fees on a proportional basis as follows:
- Indirect interests held through related parties in common control arrangements would be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests.
- This is consistent with how indirect interests held through related parties under common control are considered for determining whether a reporting entity must consolidate a VIE.
- For example, if a decision maker or service provider owns a 20 percent interest in a related party and that related party owns a 40 percent interest in the legal entity being evaluated, the decision maker’s or service provider’s indirect interest in the VIE held through the related party under common control would be considered the equivalent of an 8 percent direct interest for determining whether its fees are variable interests.
The FASB seeks comment from stakeholders (including but not limited to private company financial statement preparers, auditors, users of private company financial statements such as lenders and others), as well as non-private company stakeholders, by the Sept. 5 comment deadline. The FASB has not yet proposed an effective date for the proposed standard, indicating the board will make that determination after considering input on the proposal.